Beijing orders China's banks to lend to debt-burdened state-owned entities

The goal is to boost China's economy with an influx of funds for small businesses.

Beijing has given marching orders to China’s commercial banks, to extend “special loans” to financially distressed government entities running late on their payments to regional businesses.

While the goal is to give a boost to China’s regional economies with an influx of funds destined for smaller companies, concerns abound that the move could worsen the problem of bad loans in the all-important state-owned banking system.

The episode serves as an outstanding example of how the Chinese state continues to actively intervene in the credit-debt relations of the national economy, while fostering the growth of a market-based system and private enterprise.

Local government debt seen as economic peril

It’s no secret within China that local governments have long carried a burden of heavy debt that is a keen source of anxiety for the nation’s financial regulators.

This debt burden has arisen as a result of an unbalanced fiscal system, which forces regional authorities to bear a disproportionate share of government expenditures, while leaving them deprived of sufficient access to tax-based revenues.

Chinese economists have long urged Beijing to address the issue, on the grounds that these mounting debts could become a trigger for systemic risk in the financial sector.

Key concerns have included the use of land sales by regional authorities as a revenue source - incentivising the formation of regional property bubbles - as well as the use of local government financing vehicles (LGFV) to covertly amass hidden debts

A related dilemma has been the widespread failure of financially distressed state-owned entities to make payments on schedule, to regional businesses whose goods and services they’ve procured.

This is believed to have put a major brake on economic activity around China, by depriving small and medium-sized enterprises of the funds they urgently need to keep their businesses ticking.

The need for these funds has been especially keen for Chinese businesses in the wake of the havoc created by the Covid pandemic, as well as the trade uncertainties that continue to fester between Beijing and Washington.

Chinese banks told to make special loans to state entities

China’s financial authorities are now making haste to address the issue, in a bid to keep economic activity on an even keel as the end of the year fast approaches.

They’ve ordered the Chinese banking system to extend special loans to state-owned enterprises and government platforms in financial distress, in order to clear the late payments they owe to small-and medium-sized businesses.

China’s policymakers hope the move will help give a boost to regional economies, by providing smaller private companies with an infusion of funds, while also helping to lift market expectations and stabilise corporate lending.

They also hope to alleviate the financial pressures on defaulting state-owned entities, still struggling with the burden of their unpaid debts.

State-owned news outlet Jiemian reports that Chinese banks have created a special category of loan for clearing overdue payments, with the issuance of such loans surging abruptly since the start of the second half.

The “special loans for clearing overdue payments” (清欠专项贷款) refer specifically to loans made by Chinese banks to “state-owned enterprises, public institutions and government financing platforms,” for the purpose of discharging overdue payments owed to small and medium-sized businesses.

According to the report entitled “The Concentrated Deployment of Special Loans for Clearing Late Payments - What, Why and the Impacts” (清欠专项贷款密集落地：是什么，为什么，有何影响？), Hunan province, Shandong province, Guangxi province, Fujian province and the Ningxia autonomous zone have already made use of the special loans to help out beleaguered government companies, with both state-owned and joint-stock banks compelled to take part.

Chinese financial commentator Xia Xinyu (夏心愉) points out that a key area of focus has been government companies in the healthcare system, with one leading municipal hospital in northeastern China recently obtaining a loan of nearly 10 million yuan from a joint-stock bank.

In order to facilitate the lending process, Chinese authorities have also ordered parties in the financial sector to provide credit guarantees to some of these distressed state-owned entities seeking special loans.

Given that public institutions and state-owned enterprises are considered high-quality borrowers - irrespective of their financial straits - the guarantees have helped to bring the rates for the special loans to very low levels.

They’re reported to currently stand at around the one-year loan prime rate (LPR) minus 40 basis points - or around 2.6%.

Xia Xinyu highlights the heavy hand of the Chinese government in driving the banks to step up the provision of special loans, as opposed to extend them of their own volition for reasons of commercial interest.

“This isn’t at all the result of spontaneous action by the banks,” Xia writes in a recent commentary.

“It’s the result of concern on the part of regulators for the real economy, and driving banks to raise their awareness and engage in further hard work.”

Beijing anticipates economic boost from forced lending

China’s policymakers made it an official priority to clear the overdue debts of state-owned entities at the start of the year, in the hope of providing a boost to the economy amidst the uncertainty created by Trump’s second term as president.

The State Council held an executive meeting on March 28 to approve the “Action Plan for Accelerating the Clearing of Overdue Payments to Enterprises” (加快加力清理拖欠企业账款行动方案).

A month later, a meeting of the Politburo held on April 25 continued to emphasize “accelerating the resolution of the problem of the overdue payments owed by local government enterprises.”

In addition to banking-sector measures, local governments are also using special-purpose bonds to to make overdue payments.

According to data compiled by Jiemian, the total amount of special-purpose bonds used to repay overdue payments across 10 Chinese provinces was close to 200 billion yuan as of the end of September.

“Clearing overdue payments to enterprises is an important tool for boosting market expectations, promoting the development of the private economy, clearing out the ‘arteries’ of the economic cycle, and maintaining the government’s credibility,” Chinese officials in Jilin province said during a recent video conference.

Wen Bin (温彬), chief economist at China Minsheng Bank, said that one of the biggest benefits from a macroeconomic perspective is the injection of fresh vitality into the provision of credit to Chinese businesses.

“Currently, the drag on corporate loans from hidden debt resolution is gradually easing,” Wen said.

“Policies targeting local government financing vehicles (LGFVs) and public institutions for debt repayment are driving the conversion of commercial credit to bank credit.

“Quasi-fiscal forces such as policy-based financial instruments are poised for deployment.

“This, coupled with seasonal factors, has resulted in significantly better corporate medium- and long-term loan issuance in August compared to July.”

Data from the Chinese central bank indicates that corporate and public institution loans increased by 590 billion yuan in August, for a rise of 530 billion yuan month-on-month.

Short-term loans increased by 70 billion yuan - for an increase of 620 billion yuan month-on-month; while medium- and long-term loans increased by 470 billion yuan, for an increase of 730 billion yuan month-on-month.

While the special loans may inject fresh life into Chinese corporate credit activity, the perennial concern, of course, is that they also have the effect of perpetuating or worsening the burden of bad debts for the state-owned banks - still the mainstay of China’s financial system.

This is an issue that regulators are acutely aware of, given the nation’s recent financial history.

The severe under-performance of state-owned enterprises following the start of the reform era at the end of the 1970s led to a massive proliferation of bad loans throughout the eighties and nineties.

This mountain of non-performing loans threatened to capsize the Chinese banking system completely by the turn of the 21st century, forcing Premier Zhu Rongji to adopt bold measures to avert disaster.

Fixing the local government finance platforms

In addition to giving regional economies a cash boost, Beijing is also heavily focused on addressing the issue of local government finance vehicles (LGFVs) - the state-owned investment companies established by local governments that are a key source of covert debt accumulation.

A major concern with the LGFVs has been their ability to amass opaque, off-balance sheet debt, hidden from the prying eyes of China’s financial regulators.

For this reason, Chinese regulators are implementing a “list-based management system” for the LGFVs, in a bid to transform them into “market-oriented state-owned enterprises” - as opposed to expedient tools for debt raising by local governments.

This essentially means that LGFVs are included on special lists that restrict them from accessing new bank loans to resolve their overdue debts.

LGFVs can exit the lists, if regulators believe they have adequately dealt with the problem of their hidden debts, at which point they will have greater access to lending by banks.

The approach appears to be working. At a press conference held by the State Council Information Office on September 12, Finance Minister Lan Fo’an (蓝佛安) stated over 60% of LGFV platforms had exited the list as of the end of the second half, and that over 60% of their hidden debts had also been cleared.